Thanks Sunny.

Obviously Cable is essentially right (though you won’t be surprised to hear that I think it’s a crisis of more than just financial capitalism…). What interests me, though, is how he proposes to deliver significant re-structuring. He says it wasn’t a crisis of social democracy, and that’s right to an extent, but it was in that the weak social democratic model that Labour pushed for allowed the financialisation and inequality which he says were the causes to take place. So, my question for Cable (having not got round to reading his piece yet) is how does he propose to solve these problems?

Fred Goodwin slept with Ellen Alemany … partly related. He did loose over £24 billion in one year which is partly why we are in this economic mess.

“It runs between those who believe that 2008 was a crisis brought about by rampant financial markets and those who think it was a crisis of excessive government spending”

What about those who thought it was due to excessively low interest rates? Not all of us on the Right think that government spending caused the crash, just that it made it harder to deal with the consequences. Frankly I think it would have happened even if the Tories had been running the ship the last 10 years.

There is not much that Cable says that anyone could particularly disagree with. Of course, Labour increasing state spending did not of itself create the financial crisis and subsequent budget deficit. That is down to a plunge in the numerator (GDP). I think the best and fairest way to describe the last government and public spending is that they were indulging in the same optimistic leverage of the future as the people they were supposed to be governing. Therefore, we consistently got Mr Brown claiming that his budgets were cyclically balanced. However, they were leveraged on unsustainable revenues and when the plunge in the numerator occurred a structural deficit was exposed.

Rebalancing is all a bit wooly without actual policies where we can measure their success. It is the type of thing that everyone agrees is a good idea without actually knowing what it means. I worry when everyone agrees.

What do Labour mean when they say they should have done more to rebalance the economy? Should they have spent the same but on other things? Taxed the financial sector more and been even more exposed to a fall in revenues? They had a budget surplus until 2001, should they have continued generating a surplus? That would mean that they would not have increased spending. In fact, the share of public spending to GDP would have fallen. What exactly would they have done different with the benefit of hindsight?

“There is a dividing line in British politics. It runs between those who believe that 2008 was a crisis brought about by rampant financial markets and those who think it was a crisis of excessive government spending.”

There may be a dividing line within politics but out in the wider world there’s a general acceptance – fostered by a drip of stories and commentaries in the national press – that the current situation is solely due to excessive public spending.

This is an important activity for the conservative government as it can justify making cuts then, after the deficit is balanced, use the excess cash left over to fund tax cuts. It’s unlikely the tax cuts will be aimed at the bottom of the financial pyramid.

http://neitherangryorscared.blogspot.com/

It was malinvestment that caused the recession, that is nothing new. The reason the banks lent so much was because they could to make profit. This is also nothing new. The real question is why? Because interest rates were very low for so long. Normally interest rates would have risen before because of inflation, however the reason inflation did not rise during these years was because of outsourcing jobs to China.

Interest rates were too low compared to what? Interest rates should have risen because of inflation and they did not because we did not have inflation. So why were they too low? You do they realise that interest rates are an almost useless measure of the appropriateness of monetary policy? Low interest rates are often a sign of tight money and high interest rates a sign of easy money. The economy is currently growing slower with the Bank base rate at 0.5% compared to the rate of growth when the base rate was 5%. Hardly a sign of easy money. We did have a period of easy credit in the banking sector. However, that is quite different to saying interest rates were too low because there is zero evidence that they were.

Isn’t it good that there are healthy disagreements between ministers, that they openly disagree in full cabinet government then settle on a policy that they work together to implement constructively…

rather than pretending to be in 100% accordance, having been whipped into submission in public, whilst in fact hating and trying to undermine each other?

While Vince unconvincingly tries to straighten his cardboard halo, I wonder, wasn’t the bubble that caused the crash due to excessive house price inflation and irresponsible lending combined with super-complex financial wizzery? Where do these simple, one-factor explanations such as “it was the interest rates” arise?

Cable: “Plan A. So far this has produced two tangible benefits necessary for securing a balanced recovery through business investment and net exports. Short- and long-term interest rates are very low (negative in real terms), giving a powerful incentive to invest. A more competitive exchange rate is stimulating exports and manufacturing recovery.”

But this ONS report in May about 2011 first quarter business investment is hardly encouraging:

“Business investment in seasonally adjusted terms fell by 7.1 per cent when compared with the previous quarter to £28.1 billion and fell by 3.2 per cent when compared with the first quarter of 2010.”
http://www.statistics.gov.uk/pdfdir/bi0511.pdf

Cable himself was recently reported as threatening the banks for failing to deliver on the agreed targets in Project Merlin to increase lending to SMEs – which account for just over half of private sector jobs:
http://www.bbc.co.uk/news/business-13694198

As for looking to net exports to boost demand for British products, that isn’t looking too encouraging either:

“The balance in Britain’s trade in goods narrowed by slightly more than expected in April, aided by a small rise in exports and a larger drop in imports, official data show.

“The Office for National Statistics said the overall deficit on trade and goods and services slipped from £7.7bn in March to £7.4bn. However, the balance of trade in services slipped from £4.9bn to £4.6bn, leaving an overall trade deficit of £2.8bn, unchanged from the previous month.”
http://www.ft.com/cms/s/0/c104f364-927c-11e0-96e0-00144feab49a.html?ftcamp=rss#axzz1P5Tl0jPv

The decrease in imports is a sure sign of an economy with depressed demand.

It’s the traditional classical / Keynesian rift. Ed Balls has taken the line that the economic downturn is caused by a lack of aggregate demand. Vince Cable is taking the classical view that the economy is flatlining because we are reassessing the value of what we are currently able to produce. Given that a lot of what Britain has been “producing” recently has been higher property values there’s certainly something to what Vince Cable has to say.

The problem is those property prices are themselves a brake on rebalancing. They reduce the mobility of people looking for work and inflate the amount they have to demand for their labour.

“Interest rates were too low compared to what?”

Compared to what they would be in a free market without the central bank holding them down and pumping in extra credit which also lowers the price of money.

“Compared to what they would be in a free market without the central bank holding them down and pumping in extra credit which also lowers the price of money.”

The problem was more a mispricing of credit risk than money. The banks didn’t anticipate the probability of default on mortgages. The Bank of England doesn’t have much say about credit spreads, just the risk-free rate.

12. Richard

” Compared to what they would be in a free market without the central bank holding them down and pumping in extra credit which also lowers the price of money. ”

The central bank only sets short term interest rates. The market sets long term interest rates and that is the benchmark for credit predominately mortgages.

How do you know if there was no central bank and we had a system of free banking that interest rates would have been higher implied by saying the central bank was holding them down? You are just assuming that would be the case.

The interest rate is not the price of money. The price of money is what you must give up to get it and the nominal price of money is always 1. No one will sell you money for anything less than an interest rate of 100%, so the price of money is always 1. If widgets cost fifty pence each, the price of money is two widgets. Moreover, the price of money is the inverse of the price level i.e. when prices are high, that means that money is worth less.

The interest rate not being the price of money is the rent of money measured in money. Suppose you borrow a hundred pounds at ten percent. If the price of a pound is two widgets, you are borrowing the price of two hundred widgets and paying the price of twenty widgets a year in interest. If the money supply doubles, prices double, including the price of an widget, you are borrowing the price of a hundred widgets and paying the price of ten widgets a year in interest. Alternatively, you could do the same real transaction as before by borrowing two hundred pounds and paying twenty pounds a year interest, still at ten percent.

There is no connection between the amount of money in circulation and the interest rate. However, there is a connection between the rate of change of the amount of money in circulation and the interest rate, but it goes in the opposite of the direction that you are implying. When the money supply is increasing and prices are rising, nominal interest rates are high, not low, because lenders must be compensated for the fact that they will be paid back in pounds worth less than the ones they lent. If the BoE short-term rate had been inappropriate for the macro conditions in the economy long-term interest rates would have been rising and demand for credit would have fallen.

So, assume you have your system of free banking without a central bank. You are assuming that such a system would not have been extending as much credit. Why then assume nominal interest rates would have been higher? They would have been lower than the ones set by the BoE. Why then criticise the central bank for setting them too low? The problem in the UK leading up to the financial crisis was not an inappropriate BoE monetary policy rate, it was easy credit by the commercial banks.

“The interest rate is not the price of money.”

Indeed, it is the price of having money now rather than later. Therefore if there is an increased demand to acquire money instead of waiting to accumulate it then the price i.e. interest rate will increase.

“You are assuming that such a system would not have been extending as much credit. Why then assume nominal interest rates would have been higher?”

Because with less money being available it would be more expensive, unless people voluntarily increased savings – in which case interest rates would drop but this would be based on a genuine desire to save money rather than artificial credit increases distorting the structure of production.

I think at the end of the day we happen to differ on the purpose of the interest rate and the effects of changes in the money supply.

15. Richard

” Indeed, it is the price of having money now rather than later. Therefore if there is an increased demand to acquire money instead of waiting to accumulate it then the price i.e. interest rate will increase. ”

I think it is important to remember the difference between money and credit. They are increasing demand for credit not money. There is no relationship between the money in circulation and the interest rate only the rate of change.

” I think at the end of the day we happen to differ on the purpose of the interest rate and the effects of changes in the money supply. ”

I think you are confusing 100-percent reserve banking with free banking. Moreover, 100-percent banking is always government-sponsored banking and always has been. Here is the free banker George Selgin pointing that inescapable fact out.
http://www.freebanking.org/2011/05/31/the-state-and-100-percent-reserve-banking/